Are Pegged Cryptos Hanging Out To Dry?

Backing a cryptocurrency with hard-earned cash is a shot in the dark as it’s so difficult to predict how coins or tokens will perform.

A fast-moving market can make cryptocurrency trading seem more like a gamble as values surge, duck and dive in response to sudden and unexpected price movements.

Add to that the unknown potential of new coins that are launched almost daily, and picking a crypto winner seems almost impossible.

This problem led developers to look at ways to inject more stability into cryptocurrency trading by pegging the value of coins against other assets, like gold or the US dollar.

These coins are called stablecoins.

What Is A Stablecoin?

A stablecoin is a cryptocurrency which has a value linked or pegged to a physical asset, like fiat currencies or precious metals. The idea is to remove price volatility that can plague unpegged cryptocurrencies like Bitcoin.

For example, a dollar-pegged cryptocurrency aims to keep the coin price at $1.

Typically, to maintain the stablecoin’s price, a developer must have an equal number of dollars in reserve to match the market capitalisation of the crypto. The theory is if something goes wrong, investors can claim compensation from the developer for $1 for each coin held.

Pegged currencies have two problems –

  • If they are popular, raising enough reserve assets to cover market capitalisation is a challenge
  • A stablecoin pegged to the dollar is always worth a dollar, so traders can’t make money from the margins

How do pegged cryptocurrencies work?

Pegged cryptocurrencies or stablecoins generally opt for one of two main reserve assets – gold or the US dollar.

Some cryptos take the high-risk approach and link to another crypto or basket of cryptos.

Gold-backed cryptocurrency

Gold-backed stablecoins are valued as one unit of cryptocurrency to a predetermined unit of gold, typically a gram of the precious metal.

So, a developer minting 1 million units of cryptocurrency must have a million grams of gold held in reserve. Usually, the gold is held by a bank or financial institution acting as a custodian. This independent third party determines fair play for investors.

Many investors argue this dependence on custodians removes the decentralised, unregulated advantages of cryptocurrency.

Unlike dollar-pegged coins, traders can make profits from gold stablecoins as the price of the metal fluctuates.

Stablecoin investors need to verify the backing claims made by developers to safeguard their money.

Confirm the number of coins in circulation from the cryptocurrency’s blockchain contract and compare the data with the amount of gold held in reserve by the custodian.

Don’t forget if the gold disappears, so does the money you have invested, so keep a weather eye on the value of the reserves.

Fiat currency pegged stablecoins

Stablecoins pegged to a fiat currency – usually the US dollar – face the same storage problem as their gold-backed cousins for their piles of dollar bills.

Central banks tend to regard currency-backed products with disdain. For example, most coins pegged to the dollar are licensed, and developers must make public information about their reserves.

Investor demand is the key to a successful stablecoin. If demand is less than supply, the laws of economics say the price will fall, and this has been a problem for some developers.

Crypto-backed stablecoins

The main issue facing crypto-backed stablecoins is how much do they need to keep in reserve to account for the market’s massive volatility.

For example, a stablecoin with $1 million of Bitcoin in reserve might only mint coins worth $500,000. That way, if Bitcoin lost 30 per cent of its value, the stablecoin would have enough in reserve to cover full redemption.

Dai, a stablecoin running on the Ethereum blockchain, has a basket of cryptocurrencies in reserve that is no less than 150 per cent of market capitalisation.

Algorithmic stablecoins

Stablecoins, with their value adjusted according to an algorithm, fall into another category.

The algorithm adjusts the coin’s value based on a set of rules, like a central bank adjusts monetary policy. However, central banks have unlimited currency levels to play with, whereas pegged stablecoins have more limited resources.

The now worthless stablecoin Terra Luna is an example. Terra has two stablecoins – UST and Luna.

The algorithm burns Luna as UST is minted until the price rises above a dollar and reverses the action. The problem was the market dumped huge amounts of UST no one wanted to buy. The algorithm responded by minting Luna until the supply reached such a high level, that the price started to crash.

Developers have dumped Luna and launched a new version of Terra on a different blockchain.

Top Ten Stablecoins

These are the top ten cryptocurrency stablecoins ranked by market capitalisation:

StablecoinPriceMarket CapCirculating SupplyPegged to
USD Coin$1.00$54,925,654,42954,921,318,903US$
Binance USD$1.00$17,549,423,67317,547,224,379US$
Pax Dollar$0.9987$943,698,106945,642,940US$
Fei USD$0.9891$420,545,245424,996,178Ether
Source: Coinmarketcap

Pegged Cryptocurrency FAQ

Are pegged cryptocurrencies and stablecoins the same?

Stablecoins derive their value from a link with another asset, which can be a currency, precious metal or another cryptocurrency, instead of mining or minting. This makes stablecoins and pegged crypto the same thing.

Doesn’t pegging defeat the object of cryptocurrency?

To many, stablecoins are a hybrid cryptocurrency that tries to take the best of both worlds – the stability of a fiat currency and the decentralised features of a cryptocurrency without capitalising on either. Crypto purists argue that it’s cheaper to keep dollars in the bank rather than convert them to a pegged crypto and back into dollars.

What does burning a crypto mean?

Burning is the cryptocurrency term for removing coins or tokens from circulation to maintain the value of circulating coins. The aim is to stoke demand by reducing supply, which should boost the price of the cryptocurrency.

Can stablecoins fail?

Stablecoins can fail like any other cryptocurrency, but the degree of risk is less. The Terra Luna and UST collapsed earlier this year, while other stables, like Tether, struggled in the aftermath.

How do I buy a stablecoin?

Investors can buy stablecoins in the same way as they purchase any other cryptocurrency. The steps involve picking a wallet and exchange that are compatible with the coin or token. Link them together, transfer some money to the wallet and make the purchase from there. The wallet will store the crypto.

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